FinTechs Love the View from the Top of the Payment Hierarchy

John Wirth

Blog Post07/31/2017

“Go as far as you can see; when you get there, you’ll be able to see farther,” J.P. Morgan is known for saying in reference to obtaining and sustaining success. This seems a fitting way to think about the rise of FinTechs, a group of companies using the latest technologies, non-traditional data, and digital customer engagement to disrupt nearly every aspect of the financial services industry.

As total unsecured personal loan balances—not including student debt—surpassed $100 billion for the first time in 2016, FinTech lenders realized a disproportionate share of the growth in this market. In fact, FinTechs accounted for 30% of unsecured personal loan balances in 2016, a larger market share than banks, credit unions, and traditional finance companies.

While this is amazing growth, 2016 was also a year of turbulence for this sector as investors began to question the performance of FinTechs. Access to capital tightened, spreads widened, and company valuations declined. Despite constrained access to capital, which contracted supply to consumers, FinTechs still grew at a faster rate than other lender segments.

Given more performance history of FinTechs and their experienced credit management executives having addressed lessons learned in 2016, this sector has seen renewed investor confidence. Capital is again available to fund both the continued growth of established FinTech lenders and innovative new startups.

However, a question still lingers as investors and entrepreneurs evaluate FinTech opportunities: Given the no-touch nature of FinTechs, will consumers prioritize making a monthly payment to a remote lender?

Previous TransUnion research sheds some light on these questions…and the news is positive for FinTechs. It appears that there may be some ways that this sector can continue to achieve robust growth without taking on additional risk.

King of the Payment Hierarchy Mountain

Consumers tend to pay their unsecured personal loans first, ahead of other debts, according to a recent TransUnion Payment Hierarchy study. The report, which for the first time included unsecured personal loans, shows that consumers who have multiple credit products prioritize monthly personal loan payments over auto, mortgage and credit card payments.

Consumers Appear to Prioritize Personal Loan Payments

Payment Priority: Relief for FinTechs

I know—we were surprised too. But no matter how we sliced the data, by the types of credit products in the consumer wallet or by credit tier, unsecured personal loans came out on top.

For FinTechs, issuing personal loans that some assumed would be lowest in the payment hierarchy, discovering that consumers choose to pay their personal loans first is both a relief and an opportunity

For FinTechs, issuing personal loans that some assumed would be lowest in the payment hierarchy, discovering that consumers choose to pay their personal loans first is both a relief and an opportunity.

Consumers View Personal Loans Differently

Finding the motivation behind consumer payment choices isn’t easy. Having looked at the data, I have some ideas about consumers who strive to meet their debt obligations that may help FinTechs as they grow.

Auto Pay: While an option with many traditional lenders, the majority of FinTechs require auto pay as a basic term of service. With FinTechs now making up 30% of the personal loan market, perhaps the related proportion of personal loans set to auto pay affects the payment hierarchy results we have observed.

Lower Monthly Payment: Personal loans typically have smaller loan balances than other debt, averaging less than $7,500 over a 24-month term. The size of these loans results in lower monthly payments which appear to be easier for struggling consumers to make.

‘Light at the End of the Tunnel’: Personal loan borrowers may feel they can get a quick win with these loans. There’s a clear, near-term end to the obligation—a light at the end of the tunnel—that makes it attractive to pay personal loans ahead of longer-term debt like auto loans or mortgages.

Lender Loyalty: A conjecture of the Payment Hierarchy study is that consumers in financial distress tend to protect their most likely access path to liquidity. With personal loans broadly accessible to consumers across the credit spectrum, it appears consumers pay their personal loan first because the personal loan lender is often the most likely to extend additional credit during the consumer’s time of need.

FinTech Growth Opportunity

When reviewing this information and possible underlying consumer motivations, a lightbulb went on for me. What if FinTechs, who’ve been the vanguard for adopting differentiated risk management techniques, could improve their position on the payment hierarchy while driving additional growth?

In particular, the last point above about lender loyalty brings to mind a prior TransUnion study on consumer loyalty dynamics. That prior study showed that consumers who have multiple accounts with a given lender are both more likely to stay current in their obligations to that lender during times of financial distress and more likely to respond to new offers of credit from that lender.

We observe a positive trend between consumers' loyalty and performance

From what we see in our latest Payment Hierarchy study, FinTechs seem to have gained an advantage over traditional lenders driven by the autopay requirement and their empowering engagement approach with consumers. With the insights gained from these two TransUnion studies, it’s not difficult to see how FinTechs could fuel continued growth by expanding into additional loan categories. Not only could they grow beyond the monoline personal loan model that dominates this segment, but FinTechs may also be able to improve portfolio performance while realizing this growth.

Pursuing Smart Growth

As lenders extend more and different loan offers to the same customers, the potential loan-loss exposure to each individual borrower increases. To mitigate this risk, lenders need to develop a deeper understanding of customers in order to achieve greater confidence in their likelihood to honor repayment obligations.

Many FinTech lenders already gain a more refined view of consumer risk by looking at how consumers have performed over time. Similar to how a video enables the viewer to gain more insight into a person’s behaviors and character compared to a static photograph, trended and alternative data can provide a more comprehensive picture of consumer behavior.

Layering FCRA-compliant trended credit data and alternative data on top of traditional credit data enables lenders to identify unlikely-to-repay consumers, which traditional scores could not have identified. Additionally, non-traditional data helps identify more “good” consumers, who may have been rejected if using traditional data only. This enables more growth opportunities, without increased risk. Just Getting Started

Personal loans coming out on top of the payment hierarchy analysis has motivated us to learn more about what’s driving consumers’ behavior so we can apply insights more broadly.

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